What techniques can minimize or avoid the effects of a bankruptcy in a Virginia separation or divorce?
There are a number of techniques savvy divorce counsel can employ to minimize or avoid the effects of a bankruptcy when his or her client is separating or divorcing in Virginia. Two of the least effective, yet most common, approaches favored by divorce lawyers in the greater Richmond metropolitan area, including Chesterfield County, Hanover County, Henrico County, and the City of Richmond in separation agreements or property settlement agreements, are to declare all obligations to be support and/or to state that the agreement represents a bargained for exchange which creates support obligations. These two approaches ignore three important aspects of bankruptcy law: (1) that labeling an obligation as a “domestic support obligation” does not make it a “domestic support obligation” as defined in the Bankruptcy Code; (2) that prepetition agreements, including an agreement that a debt be treated a certain way, may still be discharged in bankruptcy; and (3) that not every legal obligation under a separation agreement or divorce decree necessarily creates a matured, pre-petition “claim” dischargeable in bankruptcy.
Labeling an obligation as support may not be effective because Section 101(14A)(B) of Title 11 of the U.S. Code, the Bankruptcy Code, establishes that a “domestic support obligation” is “in the nature of alimony, maintenance, or support (including assistance provided by a government unit) of such spouse, former spouse, or child of the debtor or such child’s parent, without regard to whether such debt is expressly so designated…[emphasis mine]. A domestic support obligation is not a domestic support obligation because it is labeled as such; instead, it must include the four elements contained in the definition in 11 U.S.C. 101(14(A).
These common approaches also ignore a second fundamental aspect of bankruptcy – that it discharges certain agreements giving rise to a claim or debt. If this were not the case, then every credit agreement would include a provision that the debt could not be discharged in bankruptcy. Agreeing that a debt is nondischargeable does not make it nondischargeable.
Finally, these approaches may ignore the distinctly different types of divorce obligations in a separation agreement, and the impact of the timing of the bankruptcy itself. For example, labeling the division of the spouses’ respective interests in jointly titled marital property as a “domestic support obligation” may be an unnecessary tradeoff in negotiations, as a breach of the obligation may not give rise to a dischargeable debt or “claim” under 11 U.S.C. 101(5), but instead simply reflect an interest in property. Similarly, the debt or claim first must come into existence, through contract or equitable distribution, before it could possibly be discharged in the other spouse’s subsequent chapter 13 filing; if either spouse has already filed bankruptcy, inchoate rights or obligations may not be affected, and it may be a fruitless waste of bargaining position to discuss the dischargeability of debts in a separation agreement (particularly if relief from stay were not first obtained).
What are some effective techniques to employ?
- Create domestic support obligations as defined by the Bankruptcy Code. Instead of merely labeling an obligation as a domestic support obligation, make sure an obligation includes the four elements contained in the definition so that it will be, in fact, a domestic support obligation nondischargeable in any type of bankruptcy.
- Render your spouse ineligible for chapter 13 relief through debt allocation or division of liabilities. Since a chapter 13 bankruptcy may allow your spouse to discharge non-DSO family law debts defined in 11 U.S.C. 523(a)(15), you want to make your spouse unable to qualify for chapter 13 relief. Here’s how you do it: there are limitations on the amount of debt, contained in 11 U.S.C. 109(e), (currently $383,175 in noncontingent, liquidated, unsecured debt and $1,149,525 in noncontingent, liquidated, secured debt) that an individual may have in order to qualify for chapter 13 relief. By properly allocating an amount of either unsecured or secured, noncontingent, liquidated debt to your spouse in excess of the maximum amount allowed, you can render your spouse ineligible for the very type of bankruptcy that would allow your spouse to discharge non-DSO family law debts to you, at least for the time being.
- Make obligations payable to you and not to a third party. There is case law support for the notion that an obligation payable directly to a third party and not to the spouse does not fit within the definition of 11 U.S.C. 523(a)(15), In re Forgette, 379 B.R. 621 (Bankr. W.D. Va., 2007), and is, therefore, not subject to the automatic stay, or nondischargeable in a chapter 13 case. You may be better off requiring your spouse to pay you directly, instead of a third party, for certain obligations, particularly if you intend to remain in possession of property securing the payment of that obligation.
- Include indemnification and hold harmless provisions on obligations payable to third parties, then incorporate the agreement as soon as possible into a court order or decree. By taking these steps, you can improve your chances of enforcement by creating an obligation to you that is not simply based on a contract, but can also be enforced through the Virginia Circuit Court judge’s contempt of court powers.
- Make contemporaneous exchanges for new value given to prevent preferential payments and structure transfers to avoid voluntary or fraudulent transfers. If you spouse files chapter 7 bankruptcy, the chapter 7 trustee may attempt to avoid and/or recover transfers of property to you as voluntary or fraudulent transfers, or as preferences under 11 U.S.C. 547, as was successfully done recently in the U.S. Bankruptcy Court for the Eastern District of Virginia, Richmond Division, in the case of Terry v. Prunty, In re: Paschall, Chapter 7 Case no: 07-32048.You should be careful to structure any transfers of property to minimize your exposure to these risks.
- Record any deeds and the separation agreement as soon as possible. As demonstrated in the Paschall case, you and your spouse meet the bankruptcy definition of an “insider”, and you may gain an advantage by recording your separation agreement and any deeds as soon as possible so the one year period for preferential payments to insiders begins to run.
- Consider that acquiring or becoming entitled to acquire any interest in property as a result of a property settlement agreement or an interlocutory or final divorce decree within 180 days after filing bankruptcy, can relate back to the filing date and become property of the bankruptcy estate under 11 U.S.C. 541(a)(5)(B).
- Seek relief from the automatic stay immediately if your spouse files bankruptcy to pursue your state court rights and remedies. You may also need a court order allowing employment of counsel for the debtor in state court and approving any separation agreement. There is some concurrent jurisdiction over family law matters in state court and bankruptcy court. In general, you should have your separation and divorce matters decided by the Virginia Circuit Court judge experienced in family-law matters, and your bankruptcy matters decided by the U.S. Bankruptcy judge experience in bankruptcy matters. Actions taken in violation of the automatic stay of bankruptcy may be void, so it is important for you to obtain relief from the stay as early as possible, should your spouse file bankruptcy, to commence or continue divorce matters in most appropriate court. Waiting to see what happens in your spouse’s bankruptcy case may work to your disadvantage if you later try to assert your state law rights in bankruptcy court.
You should consult with your Virginia family law lawyer or bankruptcy attorney to discuss the best way to structure your divorce matters in contemplation of a possible bankruptcy filing.